Why global industrial supply chains are decoupling

According to the World Trade Organization, global merchandise trade volume exceeded US$22 trillion in 2021, which represented a more than tenfold increase over 1980. The expansion of global supply chains fueled this explosion, together with major geopolitical developments that opened markets and sources of supply. Companies re-engineered their supply chains to add production sites and suppliers in Mexico, Romania, China, Vietnam and other lower-cost countries.

These tactics proved extremely cost-effective but came with inevitable trade-offs. Added complexity and physical distance, combined with innovations like just-in-time inventory management, left global supply chains more vulnerable to external disruptions.

Over the last few years, several key factors have wreaked havoc on global supply chains:

The results of the EY Industrial Supply Chain Survey demonstrate the extent to which companies are already responding to this disruption by transforming their global supply chains. Significant decoupling of existing supply chains is underway: 53% of respondents say they have already near- or re-shored some of their operations in the last 24 months, and 44% say they are planning new or additional near-shoring activities in the next 24 months. To increase geographic diversity and reduce risk, 57% say they have established new (i.e., not relocated) operations in one or more additional countries in the last 24 months and 53% are planning to do so in the next 24 months.

Changes to supplier bases are even more prevalent: 62% of respondents said their companies have made significant changes in this area in the last 24 months, and 55% say they are planning significant changes in the next 24 months. For these companies, increased diversification and proximity to their customers are key outcomes. Respondents also said they are increasing their total number of suppliers (77%) and the number of countries in which they have suppliers (63%). Large percentages also said these changes shifted their supplier footprint closer to their operations (55%) and their customers (47%).

These changes appear to trade lower costs for increased resiliency – at least in the short term. Nearly 60% of respondents who have taken or are planning such actions expect short-term (22%) or long-term (37%) cost increases as a result. However, many are also planning a range of offsetting actions, such as investments in robotics and automation to reduce labor costs (58%), temporary or permanent price increases (41%/40%), and various other efficiency-improving or cost-cutting measures (37%).

Europe

Prior to the pandemic, supply chain transformation was generally less in focus for European industrial firms than in North America, both due to the absence of geopolitical tensions on the level of US-China (Brexit aside) and generally closer proximity to lower cost operations and suppliers in Eastern Europe and Asia. However, persistent pandemic-related issues and regulatory measures like the EU’s Carbon Border Tax have prompted European companies to increasingly re-assess their supply chain architectures. The sudden and wide-ranging effects of the war in Ukraine will only reinforce this trend.

Based on survey responses from companies based in Germany, France, Spain, Italy, and the UK, the extent of operational relocation among European industrial players is similar to the US, with 55% saying they have engaged in near- or re-shoring in the last 24 months. European respondents were also likely to have made supplier base changes, with 61% saying they had done so in the last 24 months.

However, as these results were collected in March 2022, it is doubtful they fully capture the impact of war on companies’ outlooks. Given the extensive challenges related to everything from component availability (e.g., lack of automotive wire harnesses from Ukrainian suppliers) to logistics (e.g., Asia-Europe cargo routes disrupted by Russian airspace closure), European companies will be under increasing pressure to further rethink their supply chain strategies.

China

In China, the competitive industrial system, rapidly expanding domestic consumption and the Dual Circulation Strategy to place greater emphasis on its domestic market and reduce reliance on exports are driving greater independence and internal focus. Elements of the 14th Five-Year Plan (2021-25) are devoted to cultivating manufacturing clusters in key industries (e.g., integrated circuits, aerospace, robotics, advanced power equipment, engineering machinery and others) to promote local economic development. The goods from these clusters would support the aim of greater “internal circulation” or domestic consumption while also increasing “external circulation” via increased competitiveness in the global export market.

Perhaps consistent with these governmental imperatives, Chinese firms’ responses to the EY survey indicate levels of operational and supply base reshaping in line with or greater than firms in other surveyed regions. Sixty-five percent of Chinese respondents say they have near- or re-shored operations in the last 24 months. Seventy-five percent say they have made significant supplier base changes over the same period.

Selected sector observations

Firms across industrial sectors are taking steps to restructure their supply chains and remain competitive in the face of these massive external forces, with approaches varying based on relative value chain positioning, operational complexity and political sensitivity.

• Aerospace and defense companies are somewhat ahead of the curve with shorter, domestically oriented supply chains, given the sensitive nature of defense technologies. However, they continue to shift production closer to demand hubs to further improve resiliency, while employing technologies like additive manufacturing and automation to preserve margins.
• Automotive companies are shortening their supply chains by sourcing from local suppliers and building battery plants closer to US and European markets. Many automotive manufacturers have also shifted some production and raw material sourcing out of China in favor of North America, Europe and other parts of Asia to keep production lines moving, despite higher costs.
  
• Chemicals companies are diversifying supplier bases and expanding capacities closer to demand hubs. Many leading multinationals are investing heavily in China via joint ventures, partnerships and capacity expansions to ensure country-wide positioning alongside manufacturers serving both international and domestic markets. Others are simultaneously adding capacity in the US, India and other countries in Asia to reduce risk.
• Diversified industrial products manufacturers are investing to shorten their supply chains for major markets and diversify their supplier bases. Large companies are accelerating plans to add new factories in North America to simplify logistics. Some are also pursuing acquisitions to secure cost-effective access to local markets with lower tariff risk.

Like the globalization wave that preceded it, the current supply chain evolution will take several decades to unfold, and it will look different across regions and sectors. However, it is clear that this transformation has the potential to radically alter established supply chain models around the world. Given the massive impact of external forces affecting economies around the world, industrial firms need to come to terms that change is coming – and that there will be winners and losers as part of this process.

A special thank you to Joe Gaynor, EY Americas Global Development Lead AM&M Origination and Infrastructure and Christian Hainz, EY Global AM&M Senior Analyst, Knowledge for their contributions to this article.